It has been almost three decades since the start of the transition in central and eastern Europe in 1989.

The 16 countries in this region include 11 EU members (Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia) and five western Balkan countries (Albania, Bosnia and Hercegovina, Macedonia, Montenegro and Serbia).

Economic performance has been mixed for the region since 1989. Progress in convergence in income levels with the 15 EU members from before the 2004 enlargement has been modest, especially since the 2008 global financial crisis.

Several variables explain more than 90% of the inter-country variation in GDP in 2017 relative to output in 1989.

Over the longer term most central and east European countries are likely to experience only slow convergence with developed Europe.

GDP per head for the 16 central and east European countries relative to the developed west European EU15 increased from 45.8% in 1989 to 52.4% in 2017. This result masked considerable variation within the region, within the east European EU member states (the EU11) and in trends over time. Convergence for the EU11 was more rapid, whereas the western Balkan states regressed—the distance between their average incomes and EU15 levels was bigger in 2017 than in 1989.

Within the EU11 about half of the countries in the group experienced rapid convergence—Poland, Slovakia and the three Baltic states. For the Czech Republic, Slovenia, Bulgaria and Romania, and especially Hungary, the pace of convergence was more modest. One country, Croatia, was poorer relative to the EU15 in 2017 than in 1989.

GDP per head at PPP

(EU15=100)

1989

1990

1995

2000

2008

2017

Bulgaria

34.5

33.1

27.2

23.7

34.1

39.5

Croatia

56.8

54.7

38.0

41.3

50.6

48.5

Czech Republic

65.1

66.6

58.8

56.5

67.1

72.0

Estonia

46.0

43.7

31.2

37.8

53.7

58.7

Hungary

56.1

54.8

45.1

46.0

52.5

57.1

Latvia

45.9

48.9

24.9

29.2

48.7

54.2

Lithuania

54.1

53.1

28.5

32.3

53.4

63.3

Poland

31.8

29.0

34.9

39.4

46.9

59.9

Romania

33.4

32.7

27.8

23.5

35.6

42.2

Slovakia

54.1

54.3

42.0

42.4

59.2

67.9

Slovenia

69.8

68.7

62.2

66.9

78.6

75.8

Albania

15.5

14.4

12.3

13.7

19.0

23.4

Bosnia and Hercegovina

30.1

28.5

5.9

16.9

21.9

23.5

Macedonia

33.8

31.5

23.1

22.7

25.0

27.8

Montenegro

51.0

47.0

21.2

24.1

29.7

32.0

Serbia

45.8

43.5

29.8

28.4

29.7

31.1

EU11

41.8

40.5

36.5

37.5

48.0

56.3

Western Balkans

35.4

33.4

20.3

22.4

25.4

27.6

16 CEE countries

40.9

39.5

34.3

35.4

44.9

52.4

Source: The Economist Intelligence Unit.

We can distinguish three phases of the transition. The first phase, during the 1990s, especially in the first half of the decade, was marked by deep recessions and the impact of conflicts in the western Balkans. After 2000 there was rapid recovery and catch-up with the EU15 in most central and east European countries; this lasted until the 2008 global financial crisis. After that the pace of convergence slowed, especially in the western Balkans. The picture is worse if you look at convergence in terms of GDP per capita at market exchange rates. When measured in this way, there has been little convergence since the 2008 crisis. Furthermore, as GDP growth in 2009‑17 in the region was much slower than in 2001‑08, the main reason that there has been any convergence at all since 2008 is the very slow growth rate in the EU15.

Growth in real GDP per head

(% per year)

1990-2017

1990-95

1996-2000

1990-2000

2001-08

2009-17

EU11

2.4

-0.4

3.4

0.7

5.1

2.2

Western Balkans

0.4

-8.6

5.2

-3.3

5.2

0.9

16 CEE countries

2.1

-1.6

3.6

0.1

5.1

2.1

EU15

1.2

1.0

2.6

2.0

1.3

0.3

Source: The Economist Intelligence Unit.

Explaining growth during the transition

We have run a statistical regression in which several variables explain more than 90% of the inter-country variation in GDP in 2017 relative to 1989 for all the transition economies of eastern Europe. For most countries in central and eastern Europe, predicted real GDP in 2017 relative to 1989 is near the actual ratio. An index of initial conditions at the start of the transition and an indicator of whether the country was affected by war in 1989‑2017 explain about 50% of the variation in transition countries' growth in 1989‑2017. The index of initial conditions is the sum of scores on a scale of 1‑4 for each of the following: dependence on trade with the countries belonging to the Council for Mutual Economic Assistance (Comecon) in 1990; the share of services in GDP in 1989; the share of government expenditure in GDP in 1989; an assessment of the degree of prior experimentation with market reform; and an assessment of the degree of political cohesion of each society.

Other variables, all statistically significant, include income per head at the start of the transition; an indicator of natural resource wealth; the external debt/GDP ratio in 2016; an index of corruption, averaged over 1990‑2017 (a measure of the quality of institutions); and an index of progress in economic reform, averaged for 1990‑2014 for six indicators. This final index is based on an assessment by the European Bank for Reconstruction and Development (EBRD) of progress in large-scale privatisation, small-scale privatisation, governance and enterprise restructuring, trade and foreign-exchange systems, and competition policy. Debt flows had a significant negative impact, in line with the results for emerging markets in general.

A statistically significant negative coefficient for GDP per head shows that the convergence factor seen in other parts of the world also applied in the transition region: other things being equal, poorer countries grow faster. Natural resource wealth had a significant positive effect, as did institutional quality and foreign direct investment (FDI) penetration (although the result for the impact of FDI was rather weak).

Real GDP, 2017

(1989=100)

Predicted

Actual

Bulgaria

146.3

132.3

Croatia

125.5

108.3

Czech Republic

175.6

164.6

Estonia

147.3

155.0

Hungary

159.2

141.4

Latvia

127.5

126.0

Lithuania

118.5

136.8

Poland

236.1

274.3

Romania

146.7

153.4

Slovakia

175.6

188.3

Slovenia

160.7

163.5

Albania

207.6

197.7

Bosnia and Hercegovina

93.1

94.7

Macedonia

109.2

128.1

Montenegro

96.1

98.4

Serbia

81.2

80.6

EU 11

156.3

158.5

Western Balkans

117.4

119.9

16 CEE countries

144.1

146.5

Source: The Economist Intelligence Unit.

Convergence prospects

Most central and east European countries are at present enjoying strong growth. This may last for a few more years, but the longer-term prospects suggest that there will at best be only slow convergence with developed Europe. The transition growth model has reached its limits, and there is now a need to develop growth strategies that are not overwhelmingly dependent on FDI. It is possible that the countries in the region are suffering from the so-called middle-income trap—a slowdown in growth observed when an economy approaches the technological frontier. As countries develop and approach the technological frontier, their focus needs to shift from imitation to innovation.

Over the past decade most central and east European countries have made large strides in improving their business environments. However, reform momentum appears to have slowed, especially for some countries after EU accession. The region's adverse demographics and intensifying skills shortages will pose an increasingly serious challenge. Central and eastern Europe is ageing fast. In addition, strong emigration, especially of skilled workers, is set to continue. Over the past 25 years some 20m people have left the region—more than 5% of the population—most of whom were young and well educated. Large remittance inflows have generated currency appreciation pressures, dampening competitiveness.

The external economic situation is unlikely to provide the same tailwinds as before the global financial crisis. The world economy is finally picking up, but medium-term growth prospects remain subdued. Crucially important for central and eastern Europe, the IMF estimates that potential growth rate in the euro zone—the major trading partner for the region—is 20% slower than it was before the 2008 crisis.